Debt-to-Income (DTI) Ratio Guidelines for VA Loans

One key financial metric lenders consider when determining whether to approve a VA home loan is the debt-to-income (DTI) ratio.

The debt-to-income ratio is an underwriting guideline that examines the relationship between your gross monthly income and your major monthly debts. It gives VA lenders insight into your purchasing power and ability to repay debt.

Some loan types require a look at two forms of DTI ratio:

• Front-end DTI looks at the relationship between your gross monthly income and your new mortgage payment.
• Back-end DTI considers all of your major monthly expenses.

For VA loans, lenders consider only the back-end DTI ratio, which offers a more holistic look at your monthly debt and income situation.

The VA views the DTI ratio as a guide to help lenders, and it doesn’t mean borrowers with a DTI ratio above 41% can’t qualify for a VA loan. But the VA doesn't make home loans, and mortgage lenders often have in-house caps on DTI ratios that can vary depending on the borrower's credit, finances and more.

If your DTI ratio exceeds 41% at Veterans United, you must meet 120% of the residual requirement or have strong compensating factors. Every homebuyer’s situation is unique, and our team looks at the full picture to help you move towards VA homeownership.

Calculating DTI Ratio for a VA Loan

Only certain types of debts and income count toward your DTI ratio.

Lenders will consider your major revolving and installment debts, mostly pulled directly from your credit reports. These are expenses like mortgages, car loans, student loans, credit card debt and more. But lenders can also consider obligations that don't make your credit report, like child-care costs, alimony and even commuting expenses.

If you have collections or charge-offs on your credit report, lenders won't typically factor those into your DTI ratio calculation unless you're making regular monthly payments on those debts.

However, lenders may limit the amount of this derogatory credit you can have. These guidelines and policies can vary by lender.

The biggest debt is likely to be your projected monthly mortgage payment, which includes the principal and interest on the loan, estimated escrow amounts for property taxes and homeowners insurance.

Lenders will add up these debts and divide them by your gross (pre-tax) monthly income. The VA allows lenders to "gross-up" tax-free income to create a pre-tax figure to calculate the DTI ratio.

It's also important to understand that mortgage lenders don't consider all income equally. Some forms of income will count toward a mortgage without a problem.

But other forms, like overtime and self-employment income, will often require at least a two-year history. And some forms of income, like GI Bill housing allowances, won't be counted as effective income toward a mortgage.

Lenders don't count all your debts, either. Things like cell phone bills, car and health insurance, groceries and other expenses aren't factored into this calculation.

Calculating your DTI ratio is one step. But the question is: How does that number affect your ability to get a VA home loan?

VA and Lender DTI Benchmarks

Lenders can set their own benchmarks for the maximum allowable DTI ratio. Those caps, as known as VA lender overlays, can vary based on a host of factors, including the presence of compensating factors and whether the loan file needs a manual underwrite.

Some lenders may allow DTI ratios above 50%, depending on the strength of your overall credit and financial profile. In these cases, borrowers will get an up-close look at the link between DTI ratio and the VA's guideline for discretionary income, known as residual income.

DTI Ratio and Residual Income

VA residual income guidelines require borrowers to have a minimum amount of discretionary income left over each month after paying major expenses. The minimum amount varies depending on your loan amount, family size and the country you're buying in.

As part of calculating residual income, lenders estimate typical monthly costs for things like maintenance and utilities. Historically, lenders have multiplied the home’s square footage by $0.14 to estimate utility costs, though actual methods may vary.

For example, a Midwestern family of four with a loan amount greater than $80,000 would typically need $1,003 in residual income each month after paying their mortgage and other major debt obligations.

Again, VA buyers need even more residual income on hand if their DTI ratio is higher than 41%. These borrowers will need to exceed their residual income guidelines by 20% to satisfy the VA and lenders.

If our example Midwestern family of four has a DTI ratio above 41%, here's what their residual income requirement would look like:

$1,003 x 20% = $200.60

$1,003 + 200.60 = $1,203.60

Our example family of four would need about $1,204 in residual income every month to keep their loan moving forward, at least at the current loan amount. Also, keep in mind that your projected monthly mortgage payment is a huge part of your DTI ratio.

Dealing With High DTI Ratio

Having too high of a DTI ratio can force borrowers to make tough decisions.

One is to hold off on buying a home until they have a better balance of debts and income. Another option is to seek a lower loan amount. For example, if your DTI ratio is too high with a $300,000 loan, you might be able to move forward with a $250,000 mortgage.

Readjusting your homebuying budget is often disappointing, and it might not be realistic depending on your real estate market, needs and other factors. But it's an option for dealing with a high DTI ratio.

If you have questions about your debts, income and purchasing power, talk with a Veterans United VA loan expert at 855-870-8845 or get started online today.